The International Monetary Fund (IMF) warned last week that global debt hit a record-high $152 trillion at the end of last year. Global debt, as monitored by the IMF, includes debt held by governments, non-financial firms and households.
Global debt has more than doubled since 2000. Current debt levels now sit at a record 225% of global GDP, the IMF said in its semi-annual Fiscal Monitor Report – noting that about two-thirds of the liabilities reside in the private sector. The other third is held by governments.
The culprit: Slow global growth, which is making it difficult for borrowers to pay off their obligations. Many countries, including the United States, are continuing to borrow even more. The IMF warned that the massive debt overhang exacerbates the global economic slowdown.
“Excessive private debt is a major headwind against the global recovery and a risk to financial stability. History has taught us that it is very easy to under-estimate the risks associated with private debt during the upswing.”
This debt burden is mounting at a time when slow growth means inflation and interest rates will remain low, making it hard for companies, individuals and governments to earn their way out of debt. A combination of low growth, high debt and weak banks could push the world in a dangerous financial and political direction, the IMF said.
“At 225pc of world GDP, the global debt …is currently at an all-time high. Two-thirds, amounting to about $100 trillion, consists of liabilities of the private sector which can carry great risks when they reach excessive levels.
The sheer size of debt could set the stage for an unprecedented private deleveraging process that could thwart the fragile economic recovery.”
In a worst-case scenario, the IMF also fears that a wave of populist politics across the US and Europe could send globalization into reverse – with protectionist policies hitting international trade, investment and migration – sending the world plunging into a prolonged period of stagnation (read: deflation).
Why Worry About Massive Global Debt Loads?
A high debt load impairs the ability of governments to use fiscal and monetary policies to stimulate their economies. The threat of default either by sovereign entities or private corporations undermines global growth and financial stability in today’s interconnected world.
The IMF says there is no exact science to precisely predict when global debt levels become dangerous. That said, some countries have such high debt that the IMF has urged these governments, particularly Brazil and China, to tackle the excessive debt in their private sectors.
The IMF is particularly worried that declining price levels, known as deflation, are increasing the real debt burden and therefore reducing countries’ ability to grow economically. Stated differently, declining overall price levels reduce borrowers’ revenues with which to repay their obligations.
Making matters worse, only a handful of countries or private companies can refinance their debt loads at any given time. An old Wall Street maxim to debtors remains valid: “Finance when you can, not when you have to.”
Countries and private industries could lose their access to the credit markets because of unexpected shocks to the system, such as a precipitous drop in commodity prices or the insolvency of “too-big-to-fail” institutions. The ensuing financial disruptions caused by financial illiquidity can be contagious, leading to a freezing of the credit markets and/or skyrocketing unemployment.
In recent weeks, the financial press has highlighted several concerns regarding the financial solvency of European banks and state-owned enterprises in China. Deutsche Bank has become the poster child for liquidity problems. Because Deutsche Bank is Germany’s largest, its financial difficulties could have global repercussions.
On the other side of the globe, in China, The Financial Times recently estimated that its debt is 249% of gross national product. The largest share of China’s debt is soft loans to inefficient and bloated state-owned enterprises, which represent about half of China’s economy.
So, where is this all going? Unfortunately, global debt will continue to rise until it blows up. Very few world leaders are talking seriously about reducing their debt. Neither one of our presidential candidates is talking about deficit reduction or balancing the budget.
Thus, it’s only a matter of time until the next (worse) financial crisis takes us by surprise.